Wrap It Up: The Terms And Benefits Of Managed Money

By James E. McWhinney AAA

The definition of wrap account was created to refer to a product offering a multitude of services "wrapped" in a single fee. When the wrap business was a rather obscure, niche product used primarily by sophisticated institutional investors and ultra-high net-worth individual investors, everyone involved in the wrap industry understood the terminology and the product's benefits. Since then, however, the wrap industry has broadened to a wider market. Here we look at these changes as well as the benefits and vehicles of "wrapped" services. (For more information, read The Rap On Wrap Fees For Retirement Accounts.)

TUTORIAL: Stock Basics

Evolution of Wrap and Brokerage Vocabulary
When advances in technology reduced the minimum required investment, the wrap account became available to an audience of affluent retail investors. This new constituency was unfamiliar with the product's benefits, so "wrap account" was replaced with the more descriptive managed-money (account). The change in terminology focused more on communicating the product's benefits as well as its price structure (fees are still fully disclosed).

The creation of the wrap account caused changes also in the traditional language of the brokerage industry. Various factions of the investment advisory business still debate the use and appropriateness of the titles "broker" and "advisor", but the underlying economics of the debate are undisputed. The traditional definition of the term "broker" refers to an investment professional who helps match buyers and sellers in exchange for a commission. The size of a traditional broker's paycheck is based on the volume of transactions brokered, so, if no trades take place, the broker doesn't get paid, regardless of whether he or she provided any investment advice to clients.

This role of the broker changed, however, as some brokers started to offer wrap accounts, requiring them to manage money as well as complete client transactions. Thus, brokers took on the responsibilities of advisors, not only completing transactions (a service that on its own does not regard the assets currently within the client's account) but also providing portfolio management.

When an investment professional, whether a broker or advisor, works with managed-money products, he or she is paid a flat fee based on the assets under management. This fee is recurring regardless of the number of transactions that take place in the investor's account. Fee-based investing, as this business model is called, compensates investment professionals for the advice they provide, not for the number of transactions that they generate. (For more, read Full-Service Brokerage Or DIY?)

Benefits of Managed Money
When you invest in fee-based products, you receive the benefit of ongoing consultation with a professional financial advisor in exchange for a predictable fee. The advisor is responsible for managing your financial plan, which includes examining your overall financial situation, determining your risk tolerance, helping you set goals, recommending an asset allocation that is appropriate for your goals, assisting with investment selection and monitoring your portfolio and the progress toward your goals.

Because the advisor is paid based on a percentage of assets under management, he or she has a personal stake in the success of your portfolio. For example, if your advisor's fee is 1% and your portfolio contains $100,000, he or she earns $1,000 per year. If your portfolio grows to $200,000, that same 1% fee is now worth $2,000. Clearly, the advisor has a financial incentive to seek out the best available products instead of only selling those that pay the highest commissions. This arrangement lessens the investor's concern over churning, and ensures that advisors play for the same team as their clients - both client and advisor stand to win if the portfolio grows in value.

Managed-Money Investment Vehicles
There are five primary investment vehicles in the managed-money environment, each offering different features and benefits. The particulars of each vary based on the firm providing the services, but here are the general categories:

  1. Traditional Managed- or Separate-Account Programs
    Unlike mutual funds, where many investors pool their assets to access the services of a professional money manager, traditional managed-account programs (also known as "separate accounts") allow investors to contract the services of a professional money manager for an account that is separate and distinct from the accounts of other investors. These services include significant tax management and portfolio customization. Investment decisions are based on the investor's individual needs, not on the generic needs of a portfolio designed to represent a pool of investors that may number well into the thousands. (For further reading, see The Quest To Build A Unified Managed Account.)

Mutual-Fund Advisory Programs
The term "mutual fund wrap" has largely been replaced by "mutual fund advisory program" to describe a portfolio of mutual funds selected to match a preset asset allocation model appropriate for an investor's goals, offered in a single investment account together with the services of a professional investment advisor. The account is automatically rebalanced to maintain the asset allocation model, and provides consolidated performance reporting regardless of the number of mutual funds in the model. A variety of asset allocation models are available with equity-to-fixed-income proportions, such as 100% equity, 80/20, 60/40, 50/50, 40/60, 20/80 or 100% fixed income. A professional financial advisor works with the investor to determine which asset allocation model is appropriate for the investor's goals, risk tolerance, time horizon, etc., and provides ongoing guidance in the pursuit of the investor's financial objectives.

Fee-based Brokerage Accounts
Unlimited trading with no commission fees makes the fee-based brokerage account an attractive tool for frequent traders. The fee includes ongoing guidance of a professional financial advisor, and provides a measure of comfort for the do-it-yourselfer who prefers a bit of expert assistance.

Multi-Discipline Accounts
Multi-discipline accounts combine the services of multiple separate account managers into a single portfolio. This portfolio offers all the benefits of a traditional managed-account portfolio - and more - at reduced investment minimums. Activities across each of the different managers of the portfolio are coordinated by an overlay manger to maintain compliance with the wash-sale rule and minimize capital gains tax liabilities.

ETF Wraps
ETF wraps are one of the latest entrants to the managed-money arena and are similar to mutual fund wraps but use exchange-traded funds instead of mutual funds as their investment vehicles. Since ETFs have lower expense ratios than mutual funds, ETF wraps have a strong appeal to cost-conscious investors.

Is Managed Money Right for You?
Managed money offers a degree of tax efficiency, flexibility, convenience and peace of mind that few other investment options can provide. These features have made fee-based investing and managed-money investment vehicles quite popular among affluent, tax-sensitive investors. But these vehicles still pose some complexity that makes them unsuitable for a large part of the public. Before going ahead with managed money, find out if it's right for your portfolio by consulting a professional financial advisor. (Read more, in That's A (Mutual Fund) Wrap!)

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